Investors Aren’t Buying the Fed’s Hawkish Posturing

As warning signs for the economy mount, investors are cheering for more bad news. That's because they expect economic weakness will force the Federal Reserve to stop raising interest rates and eventually re-embrace loose monetary policy.

One reliable indicator over the years of an upcoming recession is an inverted yield curve. An inversion occurs when short-term interest rates rise above long-term rates.

Typically, a 3-month Treasury bill or 2-year note will yield less than a 10-year note or 30-year bond. Shorter-duration debt instruments entail less risk and therefore deliver less reward under normal circumstances. But over the past four months, short-term IOUs have begun to yield more than longer-term paper.

This week, the yield on the 10-year Treasury fell to 3.7%, while the 2-year rose to 4.4%. That represents the biggest yield curve inversion in decades.

And as institutional futures trader and broker Jim Iuorio notes, the current inversion implies strongly that a recession is coming.

Jim Iuorio: A normal sloped yield curve has longer term bonds paying higher interest rate than shorter term. The higher rate is a reward for being willing to lock up your money for longer periods of time. Economists believe that an inversion of yields is a warning sign for coming recession, as investment money seeks the safety of longer-term bonds, helping to keep those yields from rising while at the same time, in this instance, that the Federal Reserve is forcing up short-end rates through hikes. The yield curve has inverted before each recession dating back to 1955, with the recession starting between six and 24 months after the inversion. Ultimately, the curve's current lesson could be that the market believes that the Fed's aggressive hikes to fight inflation could lead to both recession and the need to quickly lower rates at some time in the future.

The U.S. economy technically dipped into a recession in the second quarter when GDP came in negative for a second consecutive quarter. At that time, however, the jobs market remained strong and the housing sector had only just begun to show signs of softening.